Your pension could well be one of your most valuable assets, whether it’s a pot of savings or entitlements built up over years of work.
But unlike other assets you might hold - like a property or other savings - pension assets are subject to their own rules when it comes to passing them on in the event of death, and the rules are different depending on the type of pension in question.
Here’s what happens to your pension when you die.
Defined contribution pensions
These are the pension pots that you pay into over your working life, with what you pay in benefiting from tax relief. They could be private pensions, including self-invested personal pensions (SIPPs) or workplace schemes where your employer contributes as well.
Here the rules are relatively straightforward - and generous. Death benefits changed in 2015 and the result has been that more and more people are using defined contribution pensions to maximise what they can potentially pass on to heirs.
If you die before the age of 75, anything in your defined contribution pensions can be passed on to anyone you wish and the recipient won’t have to pay tax on it, as long as this is done within two years of the date of death.
You can express to the company running the pension who you would like to benefit in case you die.
The money is not normally part of your estate, so no inheritance tax is due when it is paid out from the pension. Bear in mind that, if you have already started accessing your money, anything that you have withdrawn, including the potential 25% of it that is available to you tax-free, would fall inside your estate and therefore be liable for inheritance tax.
For funds still within the pension at death, beneficiaries can withdraw some or all of it, or take an income as if it were their own pension. They don’t have to be of pension age to get the money.
This assumes that you are within your own lifetime allowance for pension savings - currently £1.055 million for most - when you die. If not, then a charge may apply before the money is passed on.
If death occurs after age 75, then the money withdrawn is liable to income tax at the recipient’s marginal rate. This can limit their options because, in order to avoid an abnormally high tax bill, they may wish to take the money in chunks small enough that it does not take income above the higher rate thresholds.
It’s worth noting the Government’s Pension Wise service offers free, impartial guidance to help you understand your options at retirement. You can access the guidance online at https://www.pensionwise.gov.uk/ or over the telephone on 0800 138 3944. Fidelity’s Retirement Service also has a team of specialists who can provide you with free guidance to help you with your decisions. They can also provide advice and help you select products though this will have a charge.
Annuities take the money you have saved in defined contribution pensions and pay a guaranteed income for life in return. What happens if you die after that depends on the terms of the annuity.
You can elect to include death benefits with an annuity, although this will reduce the income you get overall.
A “joint life” annuity will continue to pay an income to a spouse or civil partner, at an agreed rate - 50% or 100% of the income, for example.
Annuities can also include a guaranteed period - up to 30 years is possible. Die within that time and an income will continue to be paid until the end of the term.
Some annuities offer value protection - which means you get back your money minus any income or tax-free cash you have received.
Defined Benefit pensions
Defined Benefit pensions are occupational plans that entitle you to a retirement income for life, typically based on your years of service at a company. Some are referred to as “final salary” schemes.
These have historically been more generous than defined contribution schemes, and more expensive to provide. As a result, there are fewer of them these days and they are often closed to new members. Public sector work is one area where they are still common.
Unlike defined contribution schemes, there is no pot of money building up but rather a promise by the scheme to one day pay an income to members. You may have to pay money in, but the income it provides does not depend on contributions, while any death benefits depend on the terms of the scheme.
Crucially, death benefits from defined benefit schemes will be taxed at the recipient’s rate of income tax. This contrasts to the tax-free options for defined contribution schemes and is one of the reasons that some people are choosing to transfer their generous defined benefit scheme to a personal pension such as a SIPP.
Death benefits are likely to be higher if you’re still an active member of the scheme - which usually means you are still an employee of the company providing it. If you have left, some schemes may only return the contributions you made, rather than benefits linked to the income you had been promised.
For still active members, death benefits are typically limited to spouses (or civil partners) and financial dependents - which usually means children living at home under the age of 18, or 23 if they are in full-time education.
If you were to die after starting to take an income from the pension, some of it may continue to be paid to your spouse or dependents, depending on the scheme’s rules. Some schemes have guaranteed periods in the event of death within which the full income is paid to the beneficiaries for a specified period.
Outside of any guaranteed period, beneficiaries usually get a proportion of the full income - a level of between half and two-thirds is typical. If you were to die before you start taking an income, beneficiaries might get a proportion of the benefits built up to that point, which will be lower.
Some schemes have clauses that reduce or remove death benefits to a spouse if they are more than 10 years younger than the scheme member, as a means to reduce liabilities on the scheme. It is also common for schemes to offer life assurance for active members - this is separate from the death benefits discussed here.
Despite state pensions being the one retirement income that almost everyone will get, the rules are even more complex here than anywhere else.
Generally, it is no longer possible to inherit a state pension from a spouse or partner. The main exception is where you have built up entitlement to additional state pension that is now protected.
There used to be a “widow’s state pension” that spouses of people who died while drawing their state pension could receive. This has now been replaced by various other benefits - the Bereavement Payment, the Widowed Parent’s Allowance and the Bereavement Allowance.
It is also possible for surviving wives to benefit from the National Insurance contributions paid by deceased husbands that reached pension age before April 2016. As much as 60% of the pension can be passed on this way.
The rules for these benefits are complex and you will need to check your eligibility for each with the Pension Service.
The value of investments and the income from them can go down as well as up, so you may get back less than you invest. Tax treatment on pensions depends on individual circumstances and all tax rules may change in the future. Withdrawals from a pension product will not be possible until you reach age 55. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.